Subordination Agreements???

When you refinance your existing mortgage, if you have a home equity line or 2nd trust, the new bank will want a subordination agreement. What is this? Is a subordination agreement some sort of mortgage gibberish, or something that is really needed?

What is a subordination agreement?

A subordination agreement is something that shows the 2nd trust lender will ‘subordinate’, or stay in 2nd trust place, when the 1st trust refinance takes place.

When a 1st trust is paid off, the 2nd trust automatically goes into 1st trust position. Of course the new lender that is paying off the old lender mandates that they get 1st trust position. Hence, the need for the ‘subordination agreement’ which shows the 2nd trust lender will stay in 2nd trust position, behind the new 1st trust loan.

What’s the problem?

Timing can be a real problem if a subordination agreement is needed. An existing equity line holder has no incentive to move quickly on processing these, as there is no profit incentive for them to do so. They are seen as a nuisance. Many banks will charge you to process these, anywhere from $75-$150 seems to be the norm.

And, the equity line holder will not process the subordination until they have a copy of the appraisal, loan application and title work. These are things that are not available on the first day of the refinancing process, they usually take at least 2 weeks. And many times an equity line bank will tell you they need 15 business days (i.e. 3 weeks) to process these subordination agreements. So if you need 2-3 weeks to get the paperwork together, and another 2-3 weeks to get the subordination agreement processed, you may exceed the “lock-in” period the new bank has agreed to hold your rate prior to settlement. And if you exceed your lock-in period, you may be subject to higher interest rates than you originally agreed to.

Appraisal value can also be a problem?

Another possible concern is the “combined loan-to-value.” An illustration will explain this best:

appraisal value of home $500,000
refinance of 1st trust mortgage $300,000
equity line cap of $175,000, current balance $5,000

This should be no problem, right? You only owe $300,000 on the 1st trust, and $5,000 on the equity line (which is $305,000 total amount owed), and with a $500,000 appraisal that gives you a 61% loan-to-value.

What it actually gives you is a 95% combined loan-to-value, because the new bank will use the maximum amount you can draw on the equity line in their calculations (which in this case is $175,000).

Repercussions

In the above example the loan would either be rejected, or they’d make you payoff and close out your equity line, or they’d ask you to modify the maximum cap down to something around an 80% combined loan-to-value. In this case that would mean:

$500,000 x 80% = $400,000
$400,000-$300,000 1st trust = $100,000

The new equity line cap would be modified to $100,000 from $175,000!

Conclusion

So refinancing can be tricky when you have an equity line, as always, talk to a very experienced mortgage professional before proceeding. Calling the 800# of a bank or calling around to every lender in the Yellow Pages may get you someone inexperienced in the subtleties of mortgage rules, and a 30-45 day loan process, an 11th hour loan rejection, and a waste of time and appraisal fees!